Emerging Markets: What has Changed

(from my colleague Ilan Solot)

1) China has changed its FX regime 

2) No coalition likely for Turkey; elections in sight 

3) Moody’s downgraded Brazil one notch to Baa3, but did not assign a negative outlook 

4) Baxico sounded a bit more hawkish, at least cosmetically 

5) Markets have welcomed the cabinet reshuffle in Indonesia 

6) Vietnam widened its currency trading band after China’s devaluation 

7) China’s devaluation reduced the value of Argentina’s FX reserves 

In the EM equity space, China (+5.9%), Argentina (+3.7%), and Russia (+1.6%) have outperformed over the last week, while Dubai (-3.4%), Indonesia (-3.9%), and Vietnam (-3.6%) have underperformed.

In the EM local currency bond space, longer-dated yields in Poland (-24 bp), Hungary (-21 bp) and Taiwan (yield -20 bp) have outperformed over the last week, while Colombia (+44 bp), Turkey (+14 bp) and Russia (+13 bp) have underperformed.  To put this in better context, the 10-year UST yield rose 4 bp over the past week.

In the EM FX space, BRL (+1%), Hungary (+0.1% vs. the euro) and Poland (flat vs. the euro) have outperformed over the last week, while MYR (-3.8%), TRY (-1.8%), and INR (-1.8%) have underperformed.

1) China has changed its FX regime. It reset the yuan to the lower end of its 2% band and announced a new mechanism that so far still looks like a "black box.” The engineered part of the devaluation seems to be over, but since market forces are meant to play a larger role, the yuan would drift lower. What we know is that the PBOC will continue to manage the currency closely. It showed this by a de facto and a verbal intervention this week.

2) No coalition likely for Turkey; elections in sight. Despite optimistic signals from both parties, the ruling AKP and the opposition HCP were unable to reach an agreement, as we had expected. On top of this, the government has openly waged war on the Kurds, a minority that composes around 20% of the country’s population, depending on how you count it. After a good performance earlier in the week, Turkish assets sold off sharply after the breakdown of coalition talks, taking USD/TRY to a new intra-session high of 2.8460. Adding fuel to the fire, an advisor to President Erdogan came out saying that a 3.0 level for the dollar against the lira as the competitive level.

3) Moody’s downgraded Brazil one notch to Baa3, but did not assign a negative outlook. This was seen as positive outcome, leading to a rally in local rates and Brazil’s sovereign CDS continuing to re-price lower. Our base case is that Brazil loses its investment grade in 2016 from S&P, but this gives the government an extra buffer to get its house in order. With the stable outlook, Moody's seems unlikely to cut again until 2016.  Fitch still has it at BBB and should be downgrading it soon.  Our own rating model has Brazil at BB+/Ba1/BB+.

4) Baxico sounded a bit more hawkish, at least cosmetically. Minutes showed that the decision to keep rates unchanged at 3.0% was not unanimous, with one member voting for a 25 bp hike. The rational was to preempt the Fed’s move and the potential disruption it may cause. This is the first split since June 2014, yet we don’t put too much weight on it. In fact, the bank trimmed its 2015 growth forecast on the back of lower oil production. Cartsens, the head of the central bank mentioned this before. If anything, we think Banxico would take other measures to mitigate any negative ripple from Fed tightening, in the FX markets for example.

5) Markets have welcomed the cabinet reshuffle in Indonesia. We see this as an important step in the right direction President Widodo has changed around his economic team yesterday and promised that a new economic plan is forthcoming to revive the economy. The new economic minister is former central governor Nasution. The Jakarta comp has been the worst performing index in Asia so far this year and the rupiah is down nearly 10% over the same period, but the announcement has given it a boost.

6) Vietnam widened its currency trading band after China’s devaluation. The band was expanded to 2% from 1% allowed fluctuation to improve flexibility and maintain competitiveness, according to the bank’s statement. We wouldn’t be surprised if the central bank decides to widen the band again. The dong has fallen 1.3% this week.

7) China’s devaluation reduced the value of Argentina’s FX reserves. It is estimated that about around $9 bln (or about a third) of the country’s reserves are yuan denominated. This is after Argentina drew on its $11 bln swap agreement with China earlier in the year. Despite the pressure on reserves, and not helped by falling commodity prices, Argentina is unlikely to devalue its currency before the presidential election on October 25.

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